Peace, at last?

How the oil markets might look like the day after

Market has been shaken by the notion of concrete advancements in the Russia-Ukraine conflict resolution, oil and the entire energy complex jittered, but what should we expect for the energy landscape? Return to the good old days? Early reaction to the news seems to indicate that but it won’t be so simple. The reality of the global energy market is far more complex, with multiple geopolitical, commercial, and logistical factors at play.

Let’s look at it first from the geopolitical lens, it is in the US best interest to stop funding a pointless war (as any other war) and turn focus on what they see as the real menace, China. Their mission to deindustrialize and leave Europe vulnerable has also been achieved. Russia on the other hand is feeling the pinch in the domestic front. Even before the latest OFAC sanctions took place the “check engine” light was flashing on the dashboard. Chinese and Indians smelled blood and went for the femoral artery (see how they slowed down their purchases since December). The financial squeeze on Russia is mounting, not just from external pressures but also internal economic strain as the ruble weakens and budget deficits grow.

Europe doesn’t have much say on this, but Europe is the key to understand where the oil market can go from here. The rationale on why the market sold off two bucks on the news was Russian oil flowing again to Europe, but is that realistic? I say NO in the near term, eventually the marginal barrel may return but in the most immediate term, not much will change. European refiners have adjusted to new supply chains, and unwinding that shift will take years. Infrastructure has changed, contracts have been rewritten, and the political stigma around Russian oil won’t disappear overnight.

Crude trade flows before and after

Unless expressly negotiated, sanctions won’t disappear from day one, at least not EU and UK which will use this as the little leverage they have. Also, to save face and to avoid signaling Putin a complete and unconditional dependance. Urals won’t be back into the Rotterdam crude diet any time soon, as they learned to cope with a lighter crude slate. The structural shift in oil consumption patterns in the last 3 years won’t be reversed even is crude is being shipped from a stone’s throw away. This is particularly relevant for Diesel/Gasoil, which remains the main concern for European refiners. The shortage of middle distillates has forced refiners to optimize operations around alternative crude sources, a process that won’t be undone quickly.

Beyond that, there are operational issues, you see, most of the Urals flowing to the Continent and specially the Meds were to Russian owned (Lukoil) refineries that have been already sold off. Main intermediaries in the Russian oil trade were Gunvor and Mercuria, which found themselves with a diminished position in Europe over the years, Gunvor shut down the Rotterdam refinery that processed this type of crude. Gazprom, Litasco that were marketing Russian product from London also left and didn’t settle all the bills before leaving I´ve been told.

Reaccepting Russian funds into the SWIFT network (which is controlled by Europe, not the U.S.) might prove tricky. There’s also the small matter of $600 billion in frozen Russian Central Bank reserves, some of which has already been spent. This issue alone could prolong the normalization process significantly, as Russia will undoubtedly demand access to those funds in any negotiated settlement.

Form a commercial standpoint, would it be wise for Russia to abandon China and India, the sole engines of demand growth? God knows how much it costs to develop new shorts in this market (shorts in trading jargon is customers with unmet demand). Those have proven to be reliable partners, although shrewd negotiators, they don’t have many objections other than price. In December Rosneft and Reliance signed a 10 year term deal for 500kbd of Urals, so there’s that at the very least. China’s love for ESPO grade will be hard to break, especially when similar WTI crude is now 10% more expensive.

Of course some of the old customers will return, Japan and South Korea could be back for remaining ESPO, Sokol, Sakhalin barrels in the Far East. CPC grades in the Black Sea might no longer carry the stigma of being blended with some Russian grades in the pipe, no more logistical constraints from loading from a Russian port (using Russian pilots and tug boats in Novorossiysk is a pain) will also make life easier for shippers.

Naphtha and Gasoil trades before and after

For product flows I do think it could be free flowing, as these markets, think of Gasoil to Brazil or naphtha all the way to Singapore are overly stretched. The US could be at the forefront of taking back some VGO and blending components from Baltic ports as they used too, more so if their intention is to intensify trade restrictions with Canada and Mexico. USGC is already quite tight in Fuel Oil and Med sours so I wouldn’t be surprised to see the first shipment to a G7 country crossing the Atlantic. For Gasoil, it will probably will find it’s way into Europe somehow, Maltese blend, Latvian blend.. we have been here before. Brazilian, Venezuelan and Cuban shorts will be maintained for political reasons. But again, it won’t be from day one, but it will be the first tradeflow to readjust.

For tankers the picture looks mixed, on one hand we’ll see a heavy hit on asset values, especially in the second-hand market as values have been inflated by the constant bid of “undisclosed buyers” feeding into the dark fleet, as for rates, the long-haul voyages will continue but not at this premium, as of today a Baltic-WCI run is $8M. That will open up the market for Aframaxes that are crowding the med, a sustained Suezmaxes flow from the Black Sea, at the same time it might free up some LR2s trading exclusively clean and switch to dirty.

What about the Dark Fleet? I was running some back of the envelope calculations and wondered, did these boats make their money back? Will they ever? For “early adopters”, those bought in mid 2022 to 23 at around $45-50M they sure did, as the rates back then were $90-120k a day, but the latest wave since 2023 and specially in ’24 were on average $45k and utilization rates dropped below 50% as the dark fleet was overbuilt. Supposing all sanctions are lifted, what do you do with a 20 years old vessel? If they were VLCCs maybe they could find a home in the Iranian trade, but an Afra? Is either floating storage in Kozmino or to the scrapyard.

Clean tankers won’t have it that easy, Russia could re-deploy their own coastals in the Baltic. Product volumes could be lower as well as they focus on crude and try to revamp their domestic refinery system which is in need of a complete overhaul.

And then there are some small details to iron out. In Feb’22 I was working on little shop, that had equity stake in Russian projects, pipes, terminals, everything.. one day all those assets were seized and that meant a couple of billions written off. I even had a couple of Aframaxes on time charter that later became proud members of the dark fleet, those charter parties were breached and all I got was Иди на хуй ! (you google it)

But Ok, lets say everything goes back to the old days. Who stands to lose more (besides Ukraine)? The US, those WTI exports to Europe would be halved, the distillates trade from the US Gulf to Europe is gone, back to an unbalanced trade where Europe shifts excess gasoline. Silver lining would be a loose med sour complex.

And what about OPEC+? They seem content with current status quo where Middle East fills the gaps due to inefficiency. If Russia gets an “out of jail” free card they will have to work even harder to “balance the market”.

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I started this thought exercise to unveil some answer but I leaving with more questions. As you might see, it won’t be an easy process, and I’m counting with Brussels to throw a spanner in the wheel, never underestimate the power of regulations. If and when peace prevails, the dismantling of this web of sanctions and such will be layer by layer, so an immediate resolution is off the table, in any case will be a new normal.